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SUBORDINATED BINOMIAL OPTION PRICING
Author(s) -
Chang Carolyn W.,
Chang Jack S. K.,
Tian Yisong Sam
Publication year - 2006
Publication title -
journal of financial research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.319
H-Index - 49
eISSN - 1475-6803
pISSN - 0270-2592
DOI - 10.1111/j.1475-6803.2006.00194.x
Subject(s) - trinomial tree , binomial options pricing model , trinomial , econometrics , leverage (statistics) , valuation of options , volatility (finance) , bernoulli trial , economics , binomial distribution , valuation (finance) , mathematics , statistics , finance , discrete mathematics
We extend the binomial option pricing model to allow for more accurate price dynamics while retaining computational simplicity. The asset price in each binomial period evolves according to two independent and successive Bernoulli trials on trade occurrence/nonoccurrence and up/down price movement. Subordination leads to a trinomial tree with stochastic volatility in calendar time. We derive utility‐dependent valuation results incorporating the leverage effect and test the model empirically.